Sometimes the long drive towards a more equitable and reasonable tax system feels like it’s one step forward, two steps back.
This month, the two steps back we risk taking come in the form of unraveling a Treasury rule established under the Obama administration. Thanks to an executive order from the Trump administration, Section 385 is currently being reviewed by the Treasury Department. The rule takes aim at curbing corporate tax haven abuse — the hallmark of a tax system rigged for the few biggest multinational corporations. Preliminary estimates from Treasury found that it’s impact on offshore tax avoidance would be significant considering that the rule would raise $7.4 billion over 10 years.
The new Section 385 measures specifically limit so-called “earnings stripping,” a trick that allows any company operating in the U.S. with an international presence to lower its U.S. tax liability by making loans from its foreign affiliates to its U.S. company. What these loans do is to allow a company to strip income out of the U.S. into its foreign affiliates through exorbitant interest payments on intercompany loans. The foreign subsidiary or foreign parent company making the loans tends to be in a low- or zero-tax jurisdictions, which means that the company then pays little to no taxes on this interest income. The Treasury rule curbs this loophole by, in some cases, counting these interest payments as equity rather than debt and thus preventing them from being tax deductible.
With $2.5 trillion stashed offshore and over $100 billion in revenue lost every year to tax haven abuse, establishing the Section 385 safeguard was a huge step forward for a better tax system. The rule puts limits on a gimmick only accessible to the biggest multinational companies, winning back a more level playing field for small businesses and a more reasonable tax system that’s a little less riddled with loopholes. Though the rule didn’t entirely solve the problem of tax haven abuse, it was an effort by the Treasury Department to address what it could within its jurisdiction.
Earnings stripping hurts Americans multiple times over. First, it erodes our corporate tax base — meaning less money for public programs, a higher national debt, and higher taxes for families. Second, small businesses suffer because they must compete with businesses, not on the merits of their products and services, but on the tax gimmicks they can get away with.
Meanwhile, the multinational corporations taking advantage of the earnings stripping loophole lose nothing in using these schemes. The biggest corporations cut down their tax bill and can still essentially operate as U.S.-based companies.
As former Secretary of the Treasury Jack Lew noted when the rule was first under consideration, “Many of these companies continue to take advantage of the benefits of being based in the United States—including our rule of law, skilled workforce, infrastructure, and research and development capabilities—all while shifting a greater tax burden to other businesses and American families.”
Earnings stripping has proven to be one of the major reasons companies engage in corporate inversions. The reason is that earnings stripping further advantages foreign companies because the income being shifted escapes taxation entirely. By curbing earnings stripping, Section 385 powerfully disincentivizes moving money offshore through corporate inversions. It put us squarely on the side of American families and domestic businesses.
Undoing this important rule and punching the earnings stripping loophole back into the fabric of our tax system would send a clear message: we are interested in making tax avoidance easier, not harder, for multinational corporations.
The Treasury Department is taking comments on this rule, requesting feedback from citizens and interested parties. Submit your comments here and let the Treasury Department know that they should hold their ground on this rule and keep driving forward to put an end to tax dodging — not take steps backward.
Michelle Surka is the Tax and Budget Advocate at U.S. PIRG.